The Kenyan mobile market has been in the throes of an acute price war over the past month, following Bharti/Zain Kenya’s move to slash its prepaid rates by half, to KES 3 (US$0.035). Rivals Essar and Orange followed through with cuts of their own, with market leader Safaricom responding with an elaborate model offering deep discounts based on the value of the recharge. All these moves have combined to give Kenya arguably the lowest mobile rates in the African continent. Over the past three years, airtime prices have declined by more than 80%.

The catalyst of the latest cuts was regulatory body CCK’s decision to cut mobile termination rates further, to around $0.02. The CCK will continue to cut MTRs annually, with a long term target of KES0.99 ($0.01) by 2013, the lowest in Africa.

The CCK’s cuts, combined with increased competition and the emergence of Zain from its long slumber, will offer the stiffest challenge to Safaricom’s market’s dominance. This will be good for consumers, not so much for margins. Impact on revenue growth will be negative, and all operators will have to move quickly to broadband to make up for the voce shortfall. This may be a harbinger of what will happen elsewhere, though that is unlikely. No other regulator has cut MTRs this quickly, and this deeply.

Much as Ulysses endured the enchanting music of sirens trying to lure him to shipwreck, South African carrier MTN has been threatening to succumb to the sirens of consolidation. As the chants mount –the latest from Reliance- and MTN itself stays on the prowl for opportunities, we remain somewhat skeptical of the promise of the proposed deals. We review some of the proposed combinations.

THE ORASCOM SIREN: an African born company like MTN, Orascom Telecom is the most attractive opportunity of the bunch. It operates in two of the largest North African Markets (Algeria and Egypt), has a presence in a few small but high growth sub-Saharan African markets and features EBITDA levels well above the African average. But an Orascom deal may also be the toughest to pull off, with uncertainty looming over key assets. First, the company is embroiled in a geo-political tussle in Algeria where the government has rejected a possible buyout of Orascom unit Djezzy by MTN. Further, Orascom’s second most profitable operation, Egypt’s Mobinil, is partly owned by one MTN’s main competitors, France Telecom, who has negotiated an option to purchase Orascom’s remaining share by 2013. As for the remaining Orascom Telecom assets, they accounted for 44% of group revenues in 2009 but only 30% of the EBITDA. In other words, an Orascom without Algeria and/or Egypt is only remotely attractive.

THE RELIANCE SIREN: The Reliance siren resumed its singing last week when the Ambani brothers announced a truce in their longstanding feud by agreeing to do away with their “non-competing” agreements. This allows Anil Ambani to sell Reliance Communications without prior consent from his brother Mukesh; it also means that MTN, who had looked to purchase Reliance Communication through a share swap mechanism, can now go back to the negotiations table. Nonetheless, the asset looks a little less attractive than it did a couple of years ago. Reliance is facing substantial pressure on profitability as a result of stiff competition at home. Its revenues and earnings have dropped significantly over the past year. In addition, MTN may have a rival in Etisalat, which is also said to be interested in the Indian carrier.

THE LITTLE MERMAIDS: We believe MTN should go for smaller and sweeter assets providing both consolidation at home and a beachhead outside its current geographic footprint. Millicom would be a compelling option. The Luxemburg based operator provides some consolidation opportunities in key African markets such as Ghana and Rwanda and fills key African gaps for MTN. In addition, it would open the doors to new markets in Central and South America where the operator holds a strong position.

On February 13, Zain’s board accepted a $10.7bn offer for its African assets from India’s leading carrier Bharti, including $1.7bn in debt. The deal is expected to close within a month, the time for Bharti to close out the financing of the transaction; at first blush, this appears to be that rare transaction that works for all parties, though perhaps not as well for Bharti’s shareholders. (Please click title – Full Analysis in PDF available at www.africanext.com)

The price: the price point is at the higher end of the $7-$9bn equity valuation we had estimated for Zain’s African assets (see “How Much is Zain Africa Worth?” an AfricaNext Research Investor Note – September 2009). It values the equity of Zain’s African operations at about 7.5x projected 2009 EBITDA, a relatively rich valuation in the current African context (public pan-African carriers currently trade at 3.5x-4.5x forward EBITDA), but hardly excessive within the historical context of similar transactions.

For Zain, it’s a good sale price for a set of operations in which the Kuwaiti company had sunk around $6-$7bn over the past five years, with a nearly non-existent dividend stream. It’s a price that allows Zain to realize a profit through capital gains that would have been hard to come through dividend upstreaming alone, on a business that was dragging down its earnings. Zain will be able to pay down debt and focus capital expenditure on more profitable Middle Eastern markets. Removing Sudan from the equation was the icing on the cake, making the deal the ultimate no-brainer.   

By our estimates, Zain realized a non-weighted return of at least 30%-40% on its African investments, potentially more depending on the structure of individual capital transactions and depending on assumptions for management fees and equity contributions to CapEx.

What is Bharti getting for its money? Our analysis in a June 2009 Investor Note is still relevant:

 “The fact that Zain would even consider selling its Africa business points to heightened concerns about the deterioration of fundamentals in African mobile markets. Competition has intensified, taxation levels have risen as tax holidays have expired, the markets are as capital-intensive as ever (at a time Zain is seeking to cut CapEx levels by half) and African currencies have plunged against the dollar. […] Excluding Sudan, Zain’s African operations accounted for about 65% of the group’s subscriber base, 56% of its revenue and 50% of its EBITDA in 2008. Perhaps more significantly, they take up more than 75% of capital expenditures, yet only account for 15% of the group’s net income. Zain’s net income rose 6% in 2008; excluding Africa, net income rose 34%. For all the lofty subscriber numbers, African operations are arguably a drag on the entire group, at least for now. “

 Please download full analysis in PDF format at www.africanext.com.